While the collapse of a large financial intermediary can wreak havoc on the system because of the interconnectivity, a large business conglomerate too can play spoilsport if the banks have too much exposure to the entity, explains Tamal Bandyopadhyay.
"There have been media reports expressing concern about the exposures of Indian banks to a business conglomerate.
'As the regulator and supervisor, the RBI maintains a constant vigil on the banking sector and on individual banks with a view to maintain financial stability....
'As per the RBI's current assessment, the banking sector remains resilient and stable...'
India's central bank issued this release on February 3. It did not name the business conglomerate, but everyone is aware of what had prompted the regulator to say so.
To be sure, such a statement is not rare. Between September 2018 and March 2020, there had been at least four statements on the resilience of Indian banking system, issued by the Reserve Bank of India -- once, a joint statement with the markets regulator; another time a tweet by RBI Governor Shaktikanta Das, and yet another time in his address to the press, besides a release.
The provocation for these statements ranged from the collapse of the Infrastructure Leasing & Financial Services to the fall (and resurrection, later) of PMC Bank Ltd and the tough time Yes Bank Ltd faced.
The entities involved were different, but the central theme of the messages was the same -- assurance on financial sector stability.
More than a decade ago, in September 2008, just after the collapse of Lehman Brothers Holdings Inc, which led to the global financial crisis, the RBI had also issued a release, assuring depositors of the safety of their money -- but that concerned a particular bank, not the banking system.
On all such occasions, financial intermediaries threatened the stability of the system, forcing the RBI to step in to soothe the frayed nerves of the depositors. This time, a corporate entity is in the eye of the storm.
While the collapse of a large financial intermediary can wreak havoc on the system because of the interconnectivity, a large business conglomerate too can play spoilsport if the banks have too much exposure to the entity.
In this case, at this point, this doesn't seem so. Yes, I am talking about the Adani group.
In his interaction with the media after presenting the latest monetary policy, RBI Governor Das, once again without naming the business conglomerate, said: 'I think the whole perception (of threat to the banking system) is coming because of the drop in market capitalisation of the shares of the group. When the banks lend money to a particular group of companies, they do not lend on the basis of market capitalisation; they lend on the basis of the strength and fundamentals of the company...'
The share price of Adani Enterprise Ltd, which was Rs 128 on March 27, 2020, rose to Rs 4,189.55 on December 21, 2022, before it was mauled on the bourses recently, following the allegations of stock manipulation and accounting fraud by the US-based firm Hindenburg Research.
Both S&P Global Ratings as well as Moody's Investors Service have cut the outlook on some of the Adani group companies' credit scores but the ratings remain unchanged.
'There is a risk that investor concerns about the group's governance and disclosures are larger than we have currently factored into our ratings, or that new investigations and negative market sentiment may lead to increased cost of capital and reduce funding access for rated entities,' S&P has said.
The rating agencies do not see any risk for the Indian banks at the moment. But the cost of funds for the group will rise and it may not find it easy to borrow overseas. In such a scenario, if the Indian banks step in with open arms to meet the credit need of the group throwing caution to the wind, they will invite trouble.
Fitch Ratings believes that Indian banks' exposure to the Adani group is insufficient to present substantial risk. It also says the banks could have some unreported non-funded asset exposure, such as commitments or through holdings of Adani group bonds or equity, particularly as collateral, but such holdings are not large enough.
A Jefferies note pegs the group's debt at 0.5 per cent of bank credit in India. For public sector banks, the debt is at 0.7 per cent of total loans and for private banks, it is at 0.3 per cent.
Brokerage CLSA estimates the consolidated debt of five group companies at Rs 2.1 trillion. Of the group's total debt, Indian banks' exposure is less than 40 per cent or around Rs 80,000 crore and, within this, private banks' share is less than 10 per cent. 'Most of the incremental funding to the group for new businesses and acquisitions has come via overseas sources.'
Going by the media reports, the State Bank of India's exposure to the Adani group is Rs 27,000 crore (Rs 270 billion), roughly a little over 0.8 per cent of the bank's loan book.
For Bank of Baroda, it is not among the top 10 exposures and one-fourth of what the RBI norms permit. Punjab National Bank's exposure to the group is Rs 7,000 crore (Rs 70 billion).
Among private banks, Axis Bank Ltd's exposure to the Adani group is less than 1 per cent of its loan book and that of IndusInd Bank Ltd 0.46 per cent.
Remember, the first set of a dozen defaulters -- against whom bankruptcy proceedings were invoked in 2017 -- owed the banks Rs 3.45 trillion, and the second set of 28 defaulters Rs 2.8 trillion.
Between Bhushan Steel Ltd and Essar Steel Ltd, the banking system had a claim of at least Rs 1.05 trillion.
What does the RBI's exposure norms stipulate? A bank can lend up to 25 per cent of its net worth or tier-I capital to a group and 20 per cent to a single entity. This is in sync with global norms.
Earlier, it was as high as 40 per cent to a group and 25 per cent to a single entity. On top of that, banks could have given more for infrastructure financing, taking exposure to a group up to 50 per cent and a single entity 30 per cent of their net worth. The RBI brought it down despite intense lobbying by some of the corporate houses for higher credit limits.
The current exposure limits also include connected lending or loans given to economically-related parties. For instance, if an automaker buys parts from a supplier to the extent of more than half of what the supplier produces, a bank's exposure to the automaker is clubbed with that of auto parts supplier.
To speed up regulatory compliance, in 2017, the RBI set up an Enforcement Department. It was then Governor Urjit Patel's idea; Deputy Governor N S Vishwanathan implemented it. This has kept the banks on their toes as any serious deviation from adherence to the regulatory norms invites penalty.
One way of de-risking the banking system is deepening the corporate bond market. The size of the Indian corporate bond market in December 2022 was Rs 40.89 trillion. So far, Rs 7.86 trillion worth of bonds have been issued this fiscal year.
Besides, Indian companies' outstanding debt overseas is to the tune of Rs 11.8 trillion at the current exchange rate. In contrast, the credit portfolio of the banking system was Rs 133.4 trillion in January-end.
Indeed, we need a much larger bond market, but except for the US, probably in no other market corporations' dependence on the bond market is higher than the banking system.
Simply put, if we need to build infrastructure, the banks will have to lend. But the lending pattern must change.
Globally, for infrastructure projects, the construction risk is borne by the bond market; the banks step in at a later stage when they can smell the cash flow. In India, till recently, the trend had been the reverse.
Banks should not get into the risk of financing infrastructure at the construction stage. Let the companies borrow from the market, paying high interest rates on high-risk debt. The banks can step in later and buy out the loans, bringing down the cost of funds for the corporations. That's the way to go.
Tamal Bandyopadhyay, a consulting editor of Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd.